It may take a few months or a couple of years, but one way or another the US and other advanced economies will eventually recover from today’s crisis. The world economy, however, is unlikely to look the same.
Even with the worst of the crisis over, we are likely to find ourselves in a somewhat de-globalized world, one in which international trade grows at a slower pace, there is less external finance and rich countries’ appetite for running large current-account deficits is significantly diminished. Will this spell doom for developing countries?
Not necessarily. Growth in the developing world tends to come in three distinct variants. First comes growth driven by foreign borrowing. Second is growth as a by-product of commodity booms. Third is growth led by economic restructuring and diversification into new products. The first two models are at greater risk than the third. But we should not lose sleep over them, because they are flawed and ultimately unsustainable. What should be of greater concern is the potential plight of countries in the last group. These countries will need to undertake major changes in their policies to adjust to today’s new realities.
The first two growth models invariably come to a bad end. Foreign borrowing can enable consumers and governments to live beyond their means for a while, but reliance on foreign capital is an unwise strategy. The problem is not only that foreign capital flows can easily reverse direction, but also that they produce the wrong kind of growth, based on overvalued currencies and investments in non-traded goods and services, such as housing and construction.
Growth driven by high commodity prices is also susceptible to busts, for similar reasons. Commodity prices tend to move in cycles. When they are high, they are apt to crowd out investments in manufacturers and other, non-traditional tradables. Moreover, commodity booms frequently produce ugly politics in countries with weak institutions, leading to costly struggles for resource rents, which are rarely invested wisely.
So it is no surprise the countries that have produced steady, long-term growth during the last six decades are those that relied on a different strategy: promoting diversification into manufactured and other “modern” goods.
By capturing a growing share of world markets for manufactures and other non-primary products, these countries increased their domestic employment opportunities in high-productivity activities. Their governments pursued not just good “fundamentals” (eg, macroeconomic stability and an outward orientation), but also what might be called “productivist” policies: undervalued currencies, industrial policies and financial controls.
China exemplified this approach. Its growth was fueled by an extraordinarily rapid structural transformation towards an increasingly sophisticated set of industrial goods. In recent years, China also got hooked on a large trade surplus vis-a-vis the US — the counterpart of its undervalued currency.
But it wasn’t just China. Countries that had been growing rapidly in the run-up to the great crash of last year typically had trade surpluses (or very small deficits). These countries did not want to be recipients of capital inflows because they realized that this would wreak havoc with their need to maintain competitive currencies.
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